In this episode of Private Market Insights, we explore the considerations and nuances that go into building a strong legal team for an SMB acquisition with Kevin Henderson, Founding Partner of SMB Law Group. Throughout the episode, Kevin shares his extensive knowledge on legal diligence and the SMB acquisitions process as a whole. His firm is among the leading sources of legal advice in the small business M&A industry, providing key insights on managing legal diligence within various budgets, handling Letter of Intent (LOI) negotiations, overcoming indemnification issues, and managing broker relationships.
Our guest offers valuable advice on understanding the emotional stakes for buyers, the need for unbiased financial reviews, and the strategic approach to legal services, providing guidance for anyone considering SMB acquisitions.
Below is an overview of some of Kevin’s top legal insights from our conversation. For a comprehensive exploration of the topic, we recommend listening to the full episode:
1. Early Warning Signs in SMB Acquisitions
“The smoothest transaction ever – you look back on it and its counterparties were working together comfortably, sharing information, very open, not hiding the ball.”
Kevin Henderson
Kevin stresses the importance of clear communication on both sides of a transaction. When buyers and sellers work collaboratively to answer key questions and move an acquisition forward, a positive outcome is much more likely. On the other hand, sellers who are reluctant to share information can be a major red flag, suggesting they might be hiding something. Smooth deals are marked by open, transparent communication between all parties.
2. Bring a Private Equity Process, Not a Private Equity Attitude
“You’re talking transaction timelines from the beginning, being open with your seller of what to expect and when to expect it.”
Kevin Henderson
It is often in a buyer’s best interest to build a strong personal relationship with a seller to establish trust. This helps differentiate them from a “faceless” competitor. However, it can still be in the buyer’s best interest to act like a private equity firm when it comes to organizing the transaction process. Adopt a private equity process, Kevin advises, for smoother small business acquisitions, emphasizing the benefits of setting clear timelines and expectations with sellers from the start. By meticulously planning the deal and using checklists to track progress, you can streamline the process, minimize surprises, and enhance deal success rates.
3. Build Rapport, and Leave Bargaining to Your Lawyers
Kevin emphasizes the importance of maintaining a good relationship with the seller during acquisitions, advising buyers to let their lawyers handle tough negotiations. This strategy not only preserves goodwill but is crucial for post-sale cooperation.
4. Be aware of the Real Deal Breakers
Kevin points out that true deal breakers often have nothing to do with legal diligence. Issues like significant gaps in earnings or valuations pose the greatest risk to closing a deal, underscoring the importance of thorough financial review to prevent acquisition failures.
5. Indemnification Clauses Are Often the Most Challenging to Negotiate
“Making sure we can get the protections as extensive and as rock solid as we can from an indemnification perspective. That’s a hugely important piece for buyers to understand and focus on.”
Kevin Henderson
Kevin notes that indemnification clauses, crucial for protecting buyers against future liabilities, are often hard to negotiate. Misunderstandings, like blanket damage caps, can cause problems, highlighting the need for clear, strong indemnification terms.
6. The Growing Relevance of Reps and Warranties Insurance
Kevin observes a growing interest in reps and warranties insurance for SMB deals. While these products have historically only been used in larger deals because of their costs, a number of firms have started offering more affordable options.
7. Leveraging SMB M&A Legal Expertise for Better Deals
Kevin highlights the advantage of engaging lawyers who have specialized experience with SMB M&A deals. Unlike traditional private equity lawyers who typically adhere to specific legal models for their transactions, SMB-focused lawyers have the experience and negotiation skills to spot opportunities to secure favorable terms. Business owners may have non-traditional priorities in a negotiation, creating opportunities for win-win negotiations that leave everyone better-off.
8. The Importance of Flexibility and Dialogue
Kevin stresses the importance of understanding each other’s priorities, as this usually leads to successful negotiations. A collaborative approach helps the parties tailor deals to meet their needs as they navigate the unique aspects of SMB transactions.
9. The Personal Stakes of SMB Acquisitions
Kevin emphasizes the personal impact of SMB acquisitions, advising against self-conducted QoE analysis due to the emotional bias it might introduce. He stresses the importance of obtaining an external, objective viewpoint to navigate the emotional stakes involved for both sellers and buyers, ensuring decisions are balanced.
10. Strategic Timing in Engaging Legal Services
Kevin recommends careful timing in hiring legal help to avoid overspending early in deal negotiations. He advocates for low-cost LOI assistance to keep options open without significant financial commitment. Prioritizing business and financial diligence before major legal spending can prevent losses on deals that don’t close, preserving buyers’ financial capacity.
11. Balancing Broker Demands with Deal Desirability
“The broker is looking at this the same way… the more uncertainty you inject into their process, the less likely you are to secure the deal.”
Kevin Henderson
Kevin discusses how buyers should approach brokers with rigid and unfavorable deal processes. Buyers typically won’t be able to convince brokers to follow a more favorable process. Therefore, buyers need to thoughtfully balance potential risk inherent in the broker’s process with the desirability of the deal. His advice for buyers is to make informed choices, balancing their deal objectives with the realities of broker-imposed conditions.